Column in The Australian - We Can't Rely on Bubbles for a Sustainable Economy

Published in The Weekend Australian on 15.03.14

It is said that those who fail to learn the lessons of history are doomed to repeat them. Australia’s economic history since the turn of the century has been one of bubble, bubble, toil and trouble: a housing bubble, a mining bubble, the toil of dealing with a global economic crisis and the trouble with relying on bubbles again.

We must not again rely on bubbles for our prosperity. Yet a set of national accounts recording annual economic growth at 2.8 per cent has led commentators to declare the Australian economy is in recovery mode, successfully making the transition from a mining boom to more diversified economic growth.

To his credit, Treasurer Joe Hockey has not joined in the euphoria. He knows that a transition from a mining investment boom to sustainable alternative sources of economic growth requires more than soaring house prices and the expansion in home and apartment construction those price rises and low borrowing costs are encouraging.

From 2001 until the onset of the Global Financial Crisis in 2008 Australia’s economic growth was based on the double bubbles: first a housing bubble and then a mineral price bubble. Housing prices began rising sharply from the turn of the century until the Global Financial Crisis. Actively encouraged by government policy, the house price bubble gave homeowners large capital gains and with them, perceptions of rapidly rising personal wealth.

On the back of this perceived wealth, Australians began spending more of their incomes and saving less. It reached the point where the household savings ratio actually hit negative territory. In contrast with a long-term average of saving around 10 per cent of their income, households were actually spending more than they were earning in the mid-2000s, maxing out their multiple credit cards that the banks had sent them in the mail.

Banks were able to obtain vast amounts of easy money from overseas for on-lending to Australian homebuyers. But when the Global Financial Crisis hit it the bubble burst. The international wholesale funding market froze, bank credit evaporated and householders, worried about their jobs, became more prudent, lifting their savings ratio back to 10 per cent. If not for the previous government’s fiscal stimulus and sound prudential regulation of banks inherited from the Howard government, Australia would have gone into recession.

As the housing bubble was inflating from around 2000 a mineral price bubble joined it from 2004. China’s voracious appetite for minerals and the inability of supplying countries to quickly expand mine capacity and open new mines caused mineral prices to hit their highest levels in 140 years. Rivers of gold flowed into the Australian taxation office, as mining companies enjoyed massive profit increases and capital gains.

Much of this tax bonanza was paid out as vote-buying increases in middle-class welfare through extending family payments well up the income scale and offering a universal baby bonus.

Just as the housing bubble had to burst so the mineral price bubble has deflated. As China moves past its metals-intensive stage of development and more mine production hits the market, the mineral price bubble will deflate even further.

Yet during this double-bubble period of 2000-2008, annual labour productivity growth fell from 3½ per cent in the late 1990s to just over 2 per cent. It fell further to not much more than 1 per cent during the Global Financial Crisis.

Now, house prices are inflating again and the household savings ratio has fallen from 10.6 per cent to 9.7 per cent, causing celebration among those who claim this as evidence the economy is recovering.

But we can’t rely on bubbles for a sustainable recovery. In a small, open economy like Australia’s the only sources of sustainable growth are improving international competitiveness and increasing productivity growth. A depreciation in the exchange rate over the last few months is helping lift our competitiveness, but for this to have a real, lasting effect, the increased cost of living from higher import prices cannot simply flow through into higher incomes. After all, the world is paying us less now than it had been during the mineral price bubble.

Wage earners are playing their part. Contrary to government warnings of a wages explosion, wage growth is at its slowest in at least 16 years. But middle-class welfare payments will need to be reduced further, following the reductions of the previous Labor government. Extravagances such as the proposed new paid parental leave scheme are not affordable out of reduced national income.

As to productivity growth, it had been recovering during the post-GFC period under the previous government and is much faster than during the weak period of 2000-2008. Averaging 2.5 per cent per annum over the last two years, productivity is growing faster than at any time in the last decade. It would need to, since productivity growth has been the source of 80 per cent in the rise in Australian incomes over the last 40 years.

As the Reserve Bank points out, productivity growth tends to be stronger in industries exposed to international competition. There’s nothing like the competition blowtorch to keep industries efficient.

But productivity growth in the cosseted parts of the economy such as electricity transmission has been woeful, going backwards for years. Electricity companies have been guaranteed a rate of return of more than 8 per cent for sticking up ever more poles and wires. This protection racket has jacked up electricity prices about seven times more than the carbon price yet the Coalition’s obsession has been with the modest carbon price effect.

Seeking out the protected parts of the economy and exposing them to competition would be a good place to start in locking in the productivity revival that began in 2012. Counting again on double bubbles would bring us nothing but toil and more trouble.